Are you looking to make your next investment?
Have you worked out the tax incentives of investing in a pension?
Do you understand pension tax relief?
Whilst you are reading this article you may wish to read our page on the subject of “buy to let tax for UK landlords” where we discuss all the different types of tax that you need to be aware of. Read Here for more (opens in a new tab)
The problem — pensions can be confusing
I know from talking to clients that they are not investing in pensions. There are a number of reasons why this is the case. Here is a brief list of some of the common ones I hear:
– They can’t get access to the money now and have to wait until they retire
– Pensions themselves can be quite difficult to understand
– Pension growth is seen to be small compared to other investments
– The costs of running a pension are high
Can you relate to the above?
Are the above reasons why you are not investing in pensions right now?
If you have answered yes to these questions then you might be surprised to learn you could be missing out.
There are many advantages to pensions. These include:
– Tax relief on pension contributions
– The fact that income generated from the pension is tax-free
– The capital growth of the pension will always be tax-free until you withdraw the investment
– Pensions may be controlled by you to invest in commercial property. We have also written a more detailed article all about investing in commercial properties. Be sure to take a read.
Download your buy to let tax guide here, written by our property accountants
What is a pension anyway?
A pension, in short, is a pension scheme or arrangement whereby it provides benefits in one or more of the below circumstances:
- having reached a particular age
- serious ill-health or incapacity, or
- similar circumstances.
Types of pension benefits
The pensions tax legislation categorises the type of benefits a pension scheme will provide into the following four types of pension benefits:
Defined benefit – these schemes should provide a set amount of benefit, where the amount of benefit does not depend on how much money is within the scheme. Final salary and career average schemes are examples of defined benefit schemes.
Money purchase – also known as defined contribution. The amount of pension is not known in advance. It will depend on how much money is in the scheme. The size of the member’s pension pot in the scheme will depend on the contributions made.
Cash balance – these are a type of money purchase scheme. For the purposes of providing member benefits, the rules are the same as for money purchase/defined contribution benefits. The difference between pure money purchase and the cash balance is that the size of the member’s pension pot isn’t only dependent on the contributions that have been paid to the scheme.
Hybrid – these schemes may provide either defined benefit, money purchase or cash balance benefits. Only when benefits are drawn will the form of the benefit be set.
Types of pensions — employee contributions
An employer pension scheme is often referred to as an occupational pension scheme. It may provide benefits as outlined above for its employees under Section 150(5) of the Finance Act 2004. And Section 30 of the Finance (No 3) Act 2010.
Employees can obtain tax relief on contributions they make from their own earnings into their pension up to a maximum of:
- £3,600 (for those not paying income tax); or
- the entirety of the member’s relevant UK earnings (up to the annual allowance)
While those making pension contributions will benefit from tax relief on their contributions, this is limited to £40,000 per year (pension contributions annual allowances) and there is a lifetime contributions allowance of £1,250,000 (tax year 2014-15).
You can go back two tax years and make pension contributions to utilise your annual allowance. Therefore you could, in effect, make £120,000 of pensions contributions in two years’ time.
A note on salary sacrifice
If you make pension contributions and are not part of a “salary sacrifice scheme” then you may only receive basic tax relief from the pension scheme. As such you will need to reclaim the additional tax if you are a higher rate or additional rate taxpayer on your self-assessment. You’ll get a statement from your pension provider. This statement telling you how much tax you owe if you go above your lifetime allowance. Your pension provider will deduct the tax before you start getting your pension.
Types of pensions — employer contributions
Employers may make pension contributions for their employees. There is no limit to the amount of money that the employer may contribute on behalf of an employee. However, care must be taken not to exceed the employee’s annual pension contributions limit. Any excess may be taxable by the employee and have a surprise of a nasty tax liability. The annual pension contributions for an employee is currently £40,000.
The employer benefit of making pension contributions over salary payments is the employer’s national insurance savings. In some cases, the employer’s can save 13.8% national insurance.
Corporation tax treatment of defined benefit pensions contributions
Employers may reduce their corporation tax liability by the amount of money that they have invested in the pension as it is deemed that employer contributions are an allowable cost.
Sections 307 and 308 of the Income Tax (Earnings and Pensions) Act 2003
The contributions an employer makes to a registered pension scheme on behalf of an employee are exempt from being taxed as earnings for the employee. However, the employer’s contributions will count towards the member’s annual allowance limit. So the member may have to pay tax if the employer contributes too much.
Where the employer is a company with investment business the employer contributions will be deductible as an expense of management (Chapter 2 of Part 16 of the Corporation Tax Act 2009).
Payments made on behalf of directors and shareholders of the company
Payments made on behalf of the directors/shareholders are considered to be wholly and exclusively for the purposes of the trade. As such these contributions will benefit from corporation tax relief.
If you are part of an employer scheme and you personally make pension contributions, you are entering into a salary sacrifice arrangement whereby you get tax relief at source on pension contributions in each and every pay packet, be it weekly or monthly.
Are all the employer’s contributions towards a personal pension allowable
Payments made to employee’s pensions
As shown in the S34 Income Tax (Trading and Other Income) Act 2005, S54 Corporation Tax Act 2009 that pension contributions are allowable. This is provided that the employer pension contributions is to an employee or director of the company. Any payments made to the employee’s pension contribution will be seen as Wholly Exclusive and Necessary. HMRC will look at the case where pension contributions seem excessive to the salary provided to the employee. HMRC may take a dim view where the employee is paid £10,000 as salary but £40,000.
Any payments made from the employer to the employee’s pension contributions in a winding-up situation will not be allowed. As HMRCs website shows. There was a court case CIR v Anglo Brewing Co Ltd  12 TC 803 that has significance. In this court case, it was shown that payments to a going concern are allowed but not one that is in a winding up situation.
An employer cannot make excessive employer contributions to the market value the person would receive for the same job elsewhere.
Excessive payments made to an employer contributions example
Mrs B’s experience and qualifications could help her earn £40,000. The employer would not be allowed to make excessive contributions towards the pension. If she was paid a salary was £30,000 and made £40,000 employer pension contributions were made; the total amount would be £70,000 and this could be seen as excessive in the eyes of HMRC. Sadly there is no guidance from HMRC to say what is excessive.
However, if the employee agrees to a salary sacrifice then the employer pension contributions will be allowable. For example, the employer pension contributions will be allowable if Mrs B was paid a salary of £40,000 but chose to make a salary sacrifice. Mrs B wishes to reduce her salary by £30,000, which would then be paid to her pension. She would be paid a £10,000 salary and a £30,000 pension contribution. These costs would be allowed.
Employer pension contributions made to directors and shareholders
The relevant piece of legislation on this point is S34 Income Tax (Trading and Other Income) Act 2005, S54 Corporation Tax Act 2009. Any payments made to the directors and shareholders of a company are allowable provided it meets the Wholly Exclusive and Necessary tests. HMRC’s website shows that employer pension contributions will not be allowed if the person in question is not involved in the business. Examples being relatives of the directors or shareholders.
Practical steps you should now take to make the most of your pension
- Set up a registered pension (scheme administrator) through an agent or IFA, making sure they have permission from the Financial Conduct Authority (FCA)
- HMRC will then consider the pension registration and inform the employer/scheme administrator of their decision on whether to allow registration or not
- HMRC will provide a registration date of the pension
If you want to know more then please read our “buy to let tax tips for UK landlords” article